Mailbag Response

The Question/Comment...

Longtime TSM reader, Andy Petite commented that "I heard one of the editors of the WSJ interviewed on NPR this evening and he stated that "most" economists are now of the thought that the recession should end by the 3rd or 4th quarter, but the recovery will be very slow for the first few years ... in part due to a continuing rise in unemployment to upwards of 10% or more. Does that seem consistent with your thoughts - a recovery, albeit slow, with a continued rise in unemployment? Or are your more bearish?"

The Quick Answer...

I'm slightly more bearish than most economists - altho all tend to agree that job creation will be slow and GDP growth nominal and below the US' 2% potential throughout 2010. What I really am more bearish on is what [it appears to me] the market has priced in recovery-wise.


The Background Thoughts by TSM...

We know that the market prices in any information is has on hand and what it generally expects for the next 3-9 months (depending on how reliable the expectations for the future can be). So to me, it appears that the market and its current rally has priced in a few things:

(1) 10-10.5% unemployment, with job CREATION (even if minimal) returning early 2010.
(2) Somewhat of a "v" shaped recovery really, as opposed to the longer, slow paced recovery that is predicted by some to be "u" shaped and take until possibly the end of 2010.
(3) Positive GDP in the 3Q of 2009 and pretty decent positive GDP in the 4Q of 2009.

My reactions:

(1) I'm okay with this. I think its a little bit optimistic and that job losses might linger and that meaningful job creation won't return quickly. But even that is somewhat generally accepted nowdays.

(2) So, given that the US Consumer is the key and that I think people are too optimistic about what he can do - then yes, i think that the current rally is overbought. I mean - corporations are making money based on reduced expenses, NOT increased revenues. Retail sales came in this morning in line with the previous month or even down a little bit. Even the discount stores like Wal-Mart and Costco are disappointing a little. How can you hire new employees without growth. Business inventories don't get restocked without consumer demand. Consumer demand won't grow without jobs for the consumer. Remember, 9.7% or 9.8% (we'll find out Friday) is the UNemployment number. Nearly 18% is the UNDERemployed number, which represents that number of people that had paychecks reduced, work week hours reduced, etc. These are lifestyle adjustments that result in less spending. No matter how "optimistic" things are right now. Hope doesn't create tangible dollars in your pocket or current mortgage payments.

Let's assume that 666 on the S&P 500 was the result of the near bank-collapse and meltdown. So now that that has been saved/resolved, what was the fair value then, maybe 825 - a strong support level that emerged before and after the bank scare? Ok, so then we've had a nearly 30% increase in value from that level!!

Have you seen 30% worth of growth in companies or the economy? Do you see 30% worth of job creation or growth occuring in the next 6 months? Do you see sustainable growth 9 months from now as the stimulus funds and jobs wear off? I simply don't, but I do see a lingering weakness in the job CREATION market in the middle of 2010. So you add all of that together and I just don't understand the current market rally.

(3) This really depends on the US consumer I think and I think the market has priced in strong GDP results moreso in 2010. Personally, I think any expectations of a "strong" GDP report in the next 4 quarters is too much. I wouldn't be suprised if we got a +0.5% GDP for 3Q - altho I still don't expect it, but there are too many fluctuating things (like inventories rebuilding possibly prematurely and government spending that could influence the final number from -0.2% to +0.3%). But for 2010 and the long term, I just think growth is going to be slower than the market is saying.